Who should be in charge of the Federal Reserve? President Biden faced a difficult decision. Should he reappoint Jay Powell, a currency pigeon who thinks the spike in inflation is likely to be temporary, but who could revise his ideas in light of the evidence? Or name Lael Brainard, a money pigeon herself, who believes that the spike in inflation is likely to be temporary, but who might revise her ideas in light of the evidence?
In the end he opted for the money pigeon. Yes, okay, Powell and Brainard are not the same. Powell is, or was, a Republican; Brainard is a Democrat. Brainard took a tougher line on financial regulation after the 2008 crisis. But when it comes to the Fed’s fundamental responsibility, which is to set monetary policy, there was never the slightest doubt that the next president would be a reluctant person. to raise interest rates and eager to keep job growth at high levels.
How has this happened? Traditionally, central bank governors — the people who run institutions that, like the Federal Reserve, control the national money supply — pride themselves on their severity, their willingness to impose economic rigor. William McChesney Martin, who presided over the Fed in the 1950s, once described its role as removing the punch bowl just as the party starts to get lively, that is, raising rates as soon as there is any sign of inflation.
But the Reserve is a technocratic institution that takes ideas and analysis seriously, and is willing to revise its ideas in light of the evidence. On the eve of the 2008 crisis, he believed, quite justifiably, that prioritizing low inflation over other considerations was, in fact, the correct policy. However, since then evidence has accumulated that focusing on inflation is not enough, that is, that the Federal Reserve has been systematically withdrawing the punch bowl early.
The story begins with a famous speech by Milton Friedman in 1968. Friedman argued, contrary to what many economists of the time believed, that monetary policy could not be used to achieve sustained low levels of unemployment. Any attempt to keep unemployment below its “natural rate” would lead to increasingly accelerating inflation, and it would take a period of high unemployment for it to fall again.
The experience of the 1970s and 1980s seemed to confirm this analysis. Here we have the unemployment rate as opposed to the change in the inflation measure preferred by the Federal Reserve from 1970 to 1990. On the surface, a low unemployment rate is associated with an unstoppable rise in inflation and, indeed, it seems that for To get inflation down again, unemployment levels have to be high.
If this “accelerationist” hypothesis is accepted, the job of the Federal Reserve was not to keep unemployment low, because it could not. Rather, it should be limited to providing stability in both prices and employment.
But the point is that, at least since the mid-1990s, the data shows nothing quite like the above. If this same graph is drawn from 1995 until shortly before the pandemic, nothing proves the accelerationist hypothesis.
Specifically, unemployment fell below 4% in both the late 1990s and 2010s, in both cases without causing an acceleration in inflation, while even the very high levels of unemployment that followed 2008 did not generate the deflationary spiral that an analysis along Friedman’s line would have predicted.
And if low levels of unemployment do not result in higher inflation, it would appear that, in all probability, we have been systematically overcooling the economy, sacrificing employment and production without any need for it. While the Federal Reserve has never explicitly acknowledged this, there is no doubt that it is a remorse that currently weighs on your conscience.
Another consideration that has made the Federal Reserve more permissive is the fear that the effects of the monetary tightening will be very difficult to reverse.
Back in 1935, Mariner Eccles, another Reserve president, argued that the institution could do little to reverse deflation because it would be like pulling a rope. At the time, this made sense: the Federal Reserve had very little ability to cut interest rates because they were already close to zero. But for a long time economists took it for granted that Depression-era conditions would never repeat themselves, and that the Federal Reserve could always engineer an economic recovery whenever it wanted.
However, it turns out that, in the 21st century, interest rates can reach the point where it is no longer possible to lower them further (zero lower bound). In fact, this has been the norm since 2007. In turn, this means that while everyone is talking about the risks of inflation right now, the Federal Reserve is also concerned about overreaction to the upside. Of the prices. If you raise interest rates and that pushes the economy into recession, you might not be able to lower them enough to get us out of it again. So if you’re wondering why money pigeons rule the Reserve, it’s not just a matter of personalities or ideology. The last two decades have exposed the downsides of the hawks’ attitude, and the Federal Reserve does not want to repeat what it now quietly considers mistakes of the past.
Paul Krugman He is a Nobel Prize in Economics. © The New York Times, 2021. News Clips translation
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